Lending Club IPO a boon for online loan startups

By Heather Somerville hsomerville@mercurynews.com

Posted:
07/03/2014 11:00:00 PM PDT

Updated:
07/04/2014 10:35:11 PM PDT

SAN FRANCISCO -- The initial public offering from Lending Club, a website that matches borrowers who need small loans with investors, could help turn a whole class of once-fringe finance tech companies into household names as common as Chase or Wells Fargo.

Beginning as a scrappy Silicon Valley startup, itching to take on big banks and credit card companies, Lending Club has grown into a nearly $4 billion company that last year brokered $2.1 billion in loans. Promising investors high returns and borrowers the transparency and speed that big banks have been criticized for lacking, it has become a popular banking alternative.

"This disrupts the Wells Fargo loan officer who you don't like going to or won't approve a loan for you," said Derek Chu, senior associate at Menlo Ventures, a venture capital firm that invests heavily in marketplaces, or companies that use apps and websites to connect two people or groups to make a transaction, such as Couchsurfing and Uber.

"There is a huge difference today between the people who can get a loan and people who want a loan, and that's the market they've gone after."

Rather than making loans directly, as a bank does, the Lending Club functions as a marketplace, connecting borrowers whose creditworthiness it evaluates with investors who decide whether a particular borrower is worth their risk. The investor, who might be a financial institution or simply an individual, then has a connection with the borrower, lending the money and receiving payments through the Lending Club.

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Some of the nation's leading financial institutions have joined Lending Club as well as San Francisco-based Prosper Marketplace, a smaller but similar company, as investors, a nod to the comparative ease and cheapness of online lending. Without thousands of bank branches, ATMs and employees, these websites have a fraction of the expense, which allows them to give higher yields to investors without charging borrowers more. But marketplace lenders are not a sure bet -- borrowers default or pay late, sometimes at higher rates than commercial bank or credit card customers.

Lending Club has tapped banks including Morgan Stanley and Goldman Sachs Group to work on an initial public offering later this year, according to reports from The Wall Street Journal. The national recognition and credibility Lending Club is likely to gain as a publicly traded company could be a boon for other online lending platforms, including Prosper, which could go public as early as 2016, and Palo Alto-based Upstart.

"What we need is someone to bring broad-based national attention to us," Upstart founder Dave Girouard said. "If you walk into a bar in Chicago and ask someone who Lending Club is, they would have no idea. We need a megaphone, and if that megaphone is Lending Club's IPO, we're happy."

Lending Club's IPO will be the first of so-called marketplace businesses, and other companies including Airbnb and Uber will be watching.

"That will be a fantastic boon to other companies under this umbrella," Chu said. "If they can play by Wall Street's rules, they must really be doing something right."

In an interview with this newspaper, Lending Club founder and CEO Renaud Laplanche declined to comment on the company's progress toward an IPO; but he did say he didn't need the IPO to raise money. Rather, he said, joining Wall Street is "more about raising awareness and also giving an opportunity for the customers to be owners of the company and have a stake in the company."

Once a fringe finance startup, today Lending Club has a roster of big names and deep coffers. Its board of directors includes former U.S. Treasury Secretary Lawrence Summers, former Morgan Stanley CEO John Mack, and venture capitalist Mary Meeker of Kleiner Perkins Caufield & Byers. It has raised more than $390 million from venture and private equity firms, and Google has a roughly $1.5 billion stake in the company. Lending Club is valued at an estimated $3.8 billion -- almost seven times its $570 million valuation two years ago. Its revenue was $98 million last year, three times its earnings in 2012 and nearly eight times revenue in 2011.

Lending Club loans have more than doubled every year since 2007 for a total of more than $4 billion. The company offers personal loans from $1,000 to $35,000, and small business loans up to $100,000, according to financial filings; the typical loan size is $13,625. Rates start at about 6 percent but they can go up to 24 percent for borrowers with bad or no credit. Lending Club makes money by charging borrowers a fee up to 5 percent of the loan.

A confluence of factors helped marketplace lending websites explode in 2012: The federal government pushed interest rates low, so investors got little return on bonds and began seeking out more lucrative investments; Lending Club and Prosper say their yields are about 8 or 9 percent, handily beating the banks. And after a few years of collecting data on borrowers, both Lending Club and Prosper devised algorithms that can accurately calculate the appropriate loan size and risk of default for each borrower, and financial institutions such as BlackRock started to participate on the sites as lenders, said Brendan Ross, president of Direct Lending Investments, a Los Angeles-based hedge fund that buys online high-yield loans.

With more investors, Lending Club and Prosper could give more and bigger loans to borrowers. And the Great Recession, when popular opinion of banks soured and the small loan pipeline slowed to a trickle, helped create a consumer culture that craves an alternative, say investors and venture capitalists.

"At a bank, you fill out an application and get interviewed and two weeks later a loan officer makes a decision," said Girouard. "Increasingly there are people saying there are better and more cost-effective ways, particularly younger generations who have never walked into a bank before."

While Lending Club would be the first of its kind to go public, high-tech financial service companies have had some of the strongest IPOs over the past 12 months, said Bryan McLaughlin, a partner with consulting and professional services firm Pricewaterhouse Coopers in San Jose. Among them was San Francisco-based Xoom, an app for transferring money out of the country, which had a $116 million IPO in February, ranking it 25th out of 60 IPOs from Silicon Valley in terms of dollars raised in the second quarter.

But lending platforms have risks a regular software company does not. The service is banned in five states. And part of their revenue depends on borrowers paying on time, which doesn't always happen -- the default rate is about 3 percent. The default rate on credit cards and consumer loans from commercial banks was about 2.3 percent for the first quarter this year, according to the Federal Reserve.

Allan Roth, founder of investment advisory firm Wealth Logic, said his return on a $2,500 Lending Club investment was about 4 percent -- about half what he believed he would earn. And about 10 out of his 179 borrowers defaulted, with two more behind on payments.

"Maybe I got unlucky," he said. "But I wouldn't recommend someone put a large portion of their portfolio in it."